A recently released new book by author Michael Lewis called “Flash Boys” has created quite a bit of controversy and buzz about the dangers of so-called high-frequency trading, especially after the author was featured recently on The Daily Show with Jon Stewart.
In Lewis’ book he argues that the current market structure, which has 13 exchanges that are regulated, is being subjugated by over 80 alternative and unregulated venues which operate like exchanges. These are a type of quasi-exchange and were created with high speed traders in mind but, in Lewis’s opinion, have expanded at the expense of investors and asset managers.
He argues that the “public market” function of the exchange, allowing buyers and sellers to come together, has been destroyed by these new exchanges, and that they’re the root of a growing problem.
Considering that they use something that jailed former Wall Street investor Bernie Madoff used, payment for order flow, only makes matters worse and further complicates the market structure. In fact, it’s created massive conflict of interest issues due to investment banks that own their own venues or are investors in alternative venues. Many critics of high-frequency trading are already calling it a “cancer” because of the fact that it’s so incredibly complicated that regulation is almost impossible.
Critics say that unlike investors, high-frequency traders don’t add liquidity to the process for the institutional investor and in fact are not investors at all. They also believe that high-frequency investors have an unfair advantage, an accusation backed up by the fact that on their recent Virtual filing it was shown that they only lost money on 1 day out of the last 1239.
They also say that real asset managers have been driven out of the market and forced “underground” so that their order flow can’t be seen or read by high-frequency traders (and thus those traders won’t be able to “step ahead” of their order).
In the end, Lewis and a growing chorus of high-frequency trading detractors say that it’s a disaster for US capital markets, weakening them and threatening the existence of a capital market that’s vibrant and robust. They add that it’s causing much frustration among asset managers as well as stock mispricing.
Lewis’ book asks a lot of hard questions that, hopefully, will soon be answered including;
- Why are over 90 venues needed to trade stocks?
- Why are investment banks allowed to internalize their procedures?
- How is high-frequency trading helpful to the public marketplace?
- Why is this not seen as a conflict of interest?
Now that high-frequency trading has been exposed, hopefully the powers that be will take notice to make the changes necessary to protect what some call the best exchange in the world. Investors everywhere are crossing their fingers.
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